No. 125: Followers or Ignorants? Inflation Expectations and Price Setting Behavior of Firms

Abstract

Using a randomized survey experiment, we investigate how firms’ inflation expectations shape their price setting. We establish that firms fully pass through inflation expectations to prices in times of high inflation, consistent with Calvo pricing. When informed about central bank inflation forecasts, firms indicate significantly lower planned price increases than their untreated peers. Additionally, treated firms pass through less of their pre-treatment inflation expectations than control-group firms, even more so when additionally receiving central bank forecasts on energy and labor cost developments. Hence, communication of inflation forecasts can shift expectations and prices, and therefore serve as an effective policy tool